A Super Market for Kroger

Higher food and gasoline prices are boosting Kroger's (NYSE: KR) top line. The grocer reported its first-quarter sales were up 11.5% from a year ago. Same-store figures increased only moderately less at 9.2%, or 5.8% excluding fuel. Earnings for the quarter grew to $386 million, or $0.58 per share, from $336.6 million and $0.47 per share one year ago. This is growth of 14.7% and 23.4%, respectively, on fewer shares outstanding.

Consumers are certainly mindful of higher prices, and Kroger is being aggressive in pricing and promotion to grow sales. It was an early promoter of stimulus-check deals, offering a 10% discount on gift-card purchases. The company also launched discount programs for purchases of gasoline and generic drugs.

In past quarters, this strategy noticeably affected profit margins. Anyone can boost sales by giving products away, so margins remain the key measure for Kroger. In the first quarter, gross and operating margins were again lower compared with last year, falling by 78 and 2 basis points to 22.92% and 3.31%, respectively. However, excluding gasoline and costs from last year's labor problems, gross margin slipped only 5 basis points and operating margin rose by 2 basis points.

Kroger seems to have confidence in its ability to stabilize these margins. The company upped its previous guidance for fiscal 2008 and now sees sales growth of 4% to 5.5% and earnings growth of 9% to 12%. Accordingly, Kroger raised the lower end of its earnings-per-share guidance to $1.85 from $1.83, with the top end remaining at $1.90 EPS for the year.

Management characterizes recent food inflation as only "moderate." However, because it went such a long time with little or no price increase, it realizes consumers are reacting and changing their behaviors.

It's likely that large supermarket retailers like Kroger, SUPERVALU (NYSE: SVU) , and Safeway (NYSE: SWY) , as well as the major discounters, are picking up a bigger share of the market, if the market is defined to include restaurants and convenience stores. People are eating more meals at home and better planning their shopping trips.

Private-label offerings are another way Kroger helps its customers handle higher food costs. Typically, private labels are more profitable for retailers than national brands, and Kroger owns and manufactures many of its own products, allowing it to better control supply and profitability. The company carries three different private labels, and its upscale line, Private Selection, has been a key part of this strategy and is expected to produce more than $1 billion in sales this year.

Kroger has been aggressive in an environment where it can pay big long-term benefits. If it can stabilize or even slightly reinflate its profit margins, its increasing top line will continue to drive nice growth in profits.

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